operating agreement

Operating Agreement vs. Revocable Trust—Which One Wins?

As a member of an LLC, you have an operating agreement. But as an individual business owner, you may also have a revocable trust. When they don’t agree with or support each other, which one takes precedence in the eyes of the law?

Operating Agreement: One Side of the Equation

Let’s assume that you and a partner have formed an LLC. The two of you draw up an operating agreement to outline the business’s basic structure.

Each of you has 50% membership interest in the LLC. Through your operating agreement, you indicate that your membership interest includes:

  • the right to distributions, allocations, and information
  • the right to vote on matters that come before the members

You also specify that, in the event of a member’s death, all member interest will transfer to the surviving member. Alternatively, that member may bequeath his interest to an immediate family member—and only to that family member.

The Other Side of the Equation: Revocable Trust

Years after the formation of the LLC, your partner has completely forgotten about the operating agreement. Without giving it a second thought, he amends his revocable trust to provide a specific gift of half of the LLC’s distributions to a friend.

Then the partner dies.

His friend, armed with the information he received from the trust, shows up at the business asking for his share of the distributions.

Which has precedence: the operating agreement or the revocable trust?

The Legal Precedence

In a 2011 court case, a situation similar to this occurred. The case went to probate court. That court sided with the friend and determined that the LLC was an estate asset. Therefore, the friend was entitled to half of the distributions.

The deceased LLC member’s children appealed the decision, which was reversed in a district court of appeals.

This court stated that this particular trust provision was nullified to the extent that it was contradicted by the LLC’s operating agreement and contractual provisions.

Protect Your Assets and Business

If you are a member of an LLC, you want to protect your assets. And if you are in an LLC with another member, you want to be sure everyone is on the same page. While your operating agreement needs to be equitable, your revocable trusts should support your goals for the business.

Poulos Law Firm has more than 30 years of estate-planning experience. We ask the right questions to ensure you avoid these challenges. We can work with you, your family, and your business partners to create estate plans to meet your goals, now and into the future. Contact us to schedule your appointment and learn more.

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